17 July 2025 Several changes in final FY 2025 reconciliation legislation could benefit oil and gas industry
Final budget reconciliation legislation (H.R. 1), signed into law on July 4, 2025 (the Act), contains several provisions that could benefit the oil and gas industry, such as reductions in minimum royalty rates for production on federal lands and a new deduction for domestic research expenses. Section 50262 of the Inflation Reduction Act of 2022 (IRA) increased the minimum royalties, rents and bids for oil and gas leases on federal lands. The minimum royalty for oil and gas was 16.66%. That rate increased to 20% for reinstated leases of operators that previously failed to comply with lease requirements. The minimum rent for oil and gas leases was $3 per acre for the first two years of the lease, $5 per acre for years three through nine, and $10 per acre in year 10 or beyond. Lease rates for reinstated leases ranged from $10 to $20 for operators that previously failed to comply with lease requirements. The Act repeals Section 50262 of the IRA, restoring royalty rates for oil and gas leases on federal land to 12.5%. The minimum rent rate is restored to $1.50 per acre. The minimum bid price is restored to $3 per acre. The Act also directs the Interior Secretary to immediately resume quarterly onshore oil-and-gas lease sales and requires at least four lease sales per year to be conducted in Alaska, Colorado, Montana, North Dakota, Nevada, New Mexico, Oklahoma and Wyoming. A minimum 16.66% royalty rate applied to oil and gas production on the Outer Continental Shelf. The rate was set by Section 50261 of the IRA, which also capped the maximum royalty rate at 18.75% through August 15, 2032, at which time only the minimum rate would apply. The Act repeals Section 50261 of the IRA and amends Section 8(a)(1) of the Outer Continental Shelf Lands Act (43 U.S.C. 1337(a)(1)) to set the royalty rate for offshore oil and gas production at not less than 12.5%, but not more than 16.66%. The Act also Instructs the Interior Secretary to conduct a minimum of 30 region-wide oil-and-gas-lease sales in the "Gulf of America." At least one of those sales must be conducted before December 15, 2025. The Act requires no fewer than two lease sales to be conducted in each of the calendar years 2026 through 2039; one of which must occur before March 15 and one of which must occur between March 16 and August 15. A minimum of six offshore oil-and-gas-lease sales must be conducted in the Alaska region, with a minimum of one in each of the calendar years 2026 through 2028 and in each of the calendar years 2030 to 2032 by March 15 of each year. For each offshore lease sale conducted, the Interior Secretary must offer a minimum of 80 million acres in the "Gulf of America" and 1 million acres in the Alaska region, or all of the land available if less acreage than the applicable minimum is available for lease. The Act also restores lease sales in the National Petroleum Reserve-Alaska (NPR-A) and directs the Interior Secretary to conduct at least five lease sales under the program within 10 years of enactment. Restoration of the NPR-A is effective July 4, 2025. Other provisions are similarly effective on July 4, 2025. Oil and gas operators operating on federal land or the Outer Continental Shelf had to pay royalties on gas produced at any lease site, including on any gas that is lost to venting, flaring or negligent release through upstream operations. The Act repeals Section 50263 of the IRA, which imposed royalties on gas produced on federally leased land. Section 60012 of the IRA, which provided funding for methane emissions and waste reduction incentive programs for petroleum and natural gas systems, is also paused by the Act for 10 years until 2034. The Act significantly changes several tax provisions affecting the oil and gas industry. The Act, among others changes:
Current law allows taxpayers to claim additional depreciation (i.e., bonus depreciation) under IRC Section 168(k) in the year in which qualified property is placed in service through 2026 (with an additional year to place the property in service for qualified property with a longer production period, as well as certain aircraft). It also allows taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for certain qualified property with a longer production period, as well as certain aircraft). Bonus depreciation phases down to 80% for qualified property placed in service before January 1, 2024; 60% for qualified property placed in service before January 1, 2025; 40% for qualified property placed in service before January 1, 2026; and 20% for qualified property placed in service before January 1, 2027. Qualified property is defined as tangible property with a recovery period of 20 years or less under the modified accelerated cost recovery system, certain off-the-shelf computer software, water utility property, or certain qualified film and television productions, as well as certain qualified theatrical productions. Certain trees, vines and fruit-bearing plants also are eligible for bonus depreciation when planted or grafted. Property is generally eligible for bonus depreciation if the taxpayer has not used the property previously (i.e., it is the taxpayer's first use of the property), provided the taxpayer does not acquire the "used" property from a related party or in a carryover basis transaction). The Act permanently extends bonus depreciation and allows taxpayers to claim 100% bonus depreciation for qualified property acquired after January 19, 2025, as well as specified plants planted or grafted on or after that date. In addition, the Act modifies IRC Section 168(k)(10) to give taxpayers the option to elect to claim 40% bonus depreciation (or 60% for longer production period property or certain aircraft) in lieu of 100% bonus depreciation for qualified property placed in service during the first tax year ending after January 19, 2025 (Transitional Election). The new law (other than the Transition Election) applies to property acquired and placed in service after January 19, 2025, as well as to specified plants planted or grafted after that date. Property will not be treated as acquired after the date on which a written binding contract is entered for such acquisition. Permanent 100% bonus depreciation is a welcome development for taxpayers in the oil and gas industry, particularly for taxpayers contemplating large bonus-eligible asset acquisitions at the time of enactment. Because the acquisition of otherwise eligible property must occur after January 19, 2025, to qualify for 100% bonus depreciation, taxpayers will need to analyze whether assets placed in service after January 19, 2025, satisfy the acquisition date requirements, which will generally involve a review of the underlying purchase contracts. Property acquired on or before January 19, 2025, is subject to the bonus depreciation rules under current law. Taxpayers that do not want to immediately return to 100% expensing are afforded the option to elect a reduced bonus depreciation percentage (40% for most property) in the first tax year ending after January 19, 2025. The IRC Section 45Q credit is available to certain taxpayers for the capture and sequestration of qualified carbon oxides. The value of the tax credit is (1) $17 per metric ton if the carbon oxide is disposed in permanent geological storage, and (2) $12 per metric ton if the taxpayer utilizes the carbon oxides as a tertiary injectant and then securely stores or utilizes them in certain approved manners. For direct-air-capture facilities placed in service after December 31, 2022, the value is $36 per metric ton for carbon oxides that are disposed in secure geological storage, and $26 per metric ton if the taxpayer utilizes the carbon oxides as a tertiary injectant and then securely stores or utilizes them in an approved manner. For certain qualifying projects, IRC Section 45Q credits increase fivefold if the prevailing wage and apprenticeship provisions are met. The 12-year credit term begins on the date the equipment is placed in service if certain conditions are met. This applies to carbon capture equipment that is originally placed in service at a qualified facility on or after the date the Bipartisan Budget Act of 2018 was enacted if (1) no taxpayer has claimed a credit under IRC Section 45Q for the equipment for any prior year, (2) the facility where the equipment is placed in service is located in an area affected by a federally-declared disaster after the capture equipment was originally placed in service, and (3) the disaster resulted in the facility or equipment ceasing to operate after it was originally placed in service. Construction on projects eligible for the carbon oxide sequestration credit must begin before January 1, 2033. For carbon capture equipment placed in service after July 4, 2025, the Act provides for parity in credit values regardless of which qualified end use is deployed. Instead of allowing a credit of $12 or $17 per metric ton for projects where qualified carbon oxides are captured from an industrial or manufacturing facility, depending of the qualified end use, the modifications to IRC Section 45Q permit a credit of $17 per metric ton for all such qualified projects (which can result in a credit of up to $85 per metric ton credit so long as the taxpayer satisfies the prevailing wage and apprenticeship rules). Similarly, instead of allowing a credit of $26 or $36 per metric ton for direct-air-capture projects, depending on the qualified use, the modifications to IRC Section 45Q permit a credit of $36 per metric ton for all qualified direct-air-capture projects (which can result in a credit of up to $180 per metric ton so long as the taxpayer satisfies the prevailing wage and apprenticeship rules). Significantly, transferability for IRC Section 45Q projects is retained (except for transfers to specified foreign entities). FEOC limitations: Specified foreign entities and foreign-influenced entities cannot claim the tax credit for tax years beginning after July 4, 2025. This limitation applies to facilities placed in service after 2022. (See Tax Alert 2025-1332.) The Act is effective for tax years beginning after December 31, 2024. Carbon capture facilities or equipment must be placed in service after July 4, 2025. The Act's modifications create parity in the maximum IRC Section 45Q credit values, regardless of the qualified end use of the captured carbon oxides. These are significant changes that will provide a quicker path to market for numerous IRC Section 45Q projects. The retention of transferability of the IRC Section 45Q credits is also welcome news to carbon-capture project developers. Conversely, the FEOC limitations affect joint ventures in the carbon capture space where the venture partner is a foreign-influenced entity, among others, and may impact current projects. While the modifications are limited, taxpayers should consider how the provisions affect their project economics and structure where they have engaged partners in the deployment of carbon capture assets. IRC Section 45V provides a tax credit to produce qualified clean hydrogen for 10 years beginning on the date the facility is placed in service. The credit ranges from $0.12 to $3.00 per kg of clean hydrogen produced depending on the emissions rate of the hydrogen and whether the prevailing wage and apprenticeship requirements are met. Taxpayers may also elect to treat clean hydrogen production facilities as energy property under IRC Section 48. Repeal of the credit is effective for facilities on which construction begins after December 31, 2027. The IRC Section 45V tax credit is one of several incentives enacted to bolster domestic investments in clean hydrogen. Many oil and gas companies have been evaluating and investing in blue hydrogen projects, as blue hydrogen is produced from natural gas, coupled with carbon capture use and sequestration technologies (to reduce the carbon footprint of the produced hydrogen). These companies will need to evaluate whether the project qualifies for IRC Section 45V or whether the project is more properly aligned to the IRC Section 45Q credit. With the early termination of the IRC Section 45V credit, the potential for optionality for "blue" hydrogen projects will be eliminated for facilities that do not begin construction before 2028. For all clean hydrogen production projects, the early termination will require taxpayers to revisit future investment plans and determine if it is feasible to begin construction before December 31, 2027. The IRA allows certain credits to be transferred (see Tax Alerts 2022-1169, 2024-0933). Under IRC Section 6418, an eligible taxpayer can elect to transfer all (or any portion specified in the election) of an eligible credit to an unrelated transferee taxpayer. The Act leaves the transferability provisions largely intact but prohibits the transfer of eligible tax credits to specified foreign entities. Addition of income from hydrogen storage, carbon capture to qualifying income of certain publicly traded partnerships IRC Section 7704(d) does not treat certain publicly traded partnerships as corporations if at least 90% of their gross income comes from certain activities (i.e., "qualifying income). These activities include, but are not limited to, (1) "the exploration, development, mining or production, processing, refining, transportation … , or marketing of any mineral, or natural resources … or industrial source carbon dioxide," or (2) the transportation or storage of specified fuels. The Act expands the pool of activities that can generate qualifying income to include the transportation or storage of certain additional fuels, as well as liquified hydrogen or compressed hydrogen. Further, the Act includes certain IRC Section 45Q project-related income in the definition of qualifying income., For IRC Section 7704(d)(1)(E) purposes, qualifying income also includes income from (1) the production of electricity from any advanced nuclear facility (as defined in IRC Section 45J(d)(2)), and (2) the operation of a geothermal-related energy property described in IRC Section 48(a)(3)(A)(iii). Under current law, taxpayers must treat research or experimental expenditures, including software development costs, as chargeable to capital account and amortize those expenditures over five years (15 years for foreign research). Any capitalized research or experimental expenditures relating to property that is disposed of, retired or abandoned during the amortization period must continue to be amortized throughout the remainder of the period.
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The Act does not disturb the current law requirement under IRC Section 174 to capitalize and amortize foreign research or experimental expenditures over 15 years, beginning with the midpoint of the tax year in which the expenditures are incurred. The Act amends IRC Section 174(d) to require continued amortization of foreign research or experimental expenditures for property that is disposed of after May 12, 2025, even if the expenditures would otherwise reduce the amount realized from the disposition. The Act makes a conforming amendment to IRC Section 59(e) to exclude foreign research or experimental expenditures from the election to capitalize and recover research or experimental expenditures over 10 years. However, domestic research or experimental expenditures that are otherwise deductible under IRC Section 174A are eligible for the election under IRC Section 59(e). Lastly, the Act makes various conforming amendments to other provisions of the IRC, including a conforming amendment to IRC Section 280C(c) to provide that domestic research or experimental expenditures otherwise taken into account under Chapter 1 of the IRC (whether deducted or capitalized) are reduced by the amount of the credit allowed under IRC Section 41(a). The new law is generally effective for amounts paid or incurred for domestic research in tax years beginning after December 31, 2024. Small businesses that meet the gross receipts test under IRC section 448(c) (generally average gross receipts of $31 million or less), however, can elect to apply the new law retroactively to tax years beginning after December 31, 2021, by filing amended returns. A change to apply the new law is generally treated as a change in method of accounting under IRC Section 446. Additionally, the Act allows all taxpayers that incurred and capitalized (under IRC Section 174) domestic research or experimental expenditures after December 31, 2021, and before January 1, 2025, to elect to deduct any remaining unamortized amount with respect to such expenditures in their first tax year beginning after December 31, 2024, or ratably over the two tax year period beginning with the first tax year that begins after December 31, 2024. The election is treated as a change in method of accounting for amortization that is implemented on a cut-off basis (no IRC Section 481(a) adjustment), suggesting that the accelerated deduction retains its character as an amortization deduction. The Act makes new IRC Section 174A permanent for tax years beginning after December 31, 2024, which provides welcome certainty for taxpayers. Likewise, small businesses will undoubtedly welcome the option to elect to retroactively deduct domestic research or experimental expenditures. The election to accelerate unamortized domestic research or experimental expenditures that were capitalized under the Tax Cuts and Jobs Act (TCJA) generally benefits all taxpayers by allowing recovery of capitalized amounts in the 2025 tax year (or 2025 and 2026 tax years, at the election of the taxpayer). However, taxpayers should carefully model out the election options under the new law, including the acceleration election, due to the impact these elections can have on other provisions of the IRC, including the corporate alternative minimum tax under IRC Section 55. To implement new IRC Section 174A and/or make any of the elections described above, certain procedural requirements must be satisfied. The Act instructs the Secretary of the Treasury to publish guidance to establish certain of these procedural requirements, namely those necessary for taxpayers to avail themselves of the elections described above. Once guidance is published, it will be clearer how taxpayers can properly implement new IRC Section 174A and effectuate these elections. Unlike current IRC Section 174 provisions, IRC Section 174A does not restrict the recovery of unamortized domestic research or experimental expenditures (to the extent capitalized) in the event of disposal, retirement or abandonment of the related property. This change significantly impacts taxable income for taxpayers with substantial US research activities that dispose of research property or that abandon unsuccessful research efforts. Further, IRC Section 174A provides flexibility in cost recovery for domestic research or experimental expenditures similar to the provisions that existed before the TCJA's enactment. For taxpayers conducting research outside the United States, however, the provision does not provide any relief from required capitalization and amortization of foreign expenditures. Businesses may elect to immediately expense up to $1 million of the cost of any IRC Section 179 property placed in service each tax year. If a business places in service more than $2.5 million of IRC Section 179 property in a tax year, the immediate expensing amount is reduced by the amount by which the IRC Section 179 property's cost exceeds $2.5 million. These amounts are indexed for inflation for tax years beginning after 2018. Thus, for tax years beginning in 2025, taxpayers may expense up to $1.25 million, and the phaseout threshold is $3.13 million. IRC Section 179 property includes tangible personal property or certain computer software that is purchased for use in the active conduct of a trade or business, as well as certain "qualified real property," which is defined as QIP and any of the following improvements to nonresidential real property placed in service after the date the property was first placed in service:
The Act increases the maximum amount a taxpayer may expense under IRC Section 179 from $1 million to $2.5 million, with the phaseout increasing to $4 million, for tax years beginning after 2024. The Act reduces the $2.5 million amount (but not below zero) by the amount by which the cost of the qualifying property placed in service during the tax year exceeds $4 million. Both expensing limitation amounts are indexed for inflation for tax years beginning after 2025. IRC Section 179 permits businesses to currently deduct the full purchase price of qualifying equipment and software in the tax year the property is placed in service. The material increase in the expense amount may significantly impact strategic purchase decisions. The Act also contains a number of international provisions that could affect oil and gas companies with foreign operations. Below are the key substantive international provisions in the Act:
Document ID: 2025-1508 | ||||||
